The Development: The EU General Court annulled the European Commission's decision in the Apple case, holding that the Commission did not prove that the Irish tax rulings in question gave rise to a selective advantage under EU State aid rules.
The Result: Following the Fiat and Starbucks cases, this ruling acknowledges that the Commission is empowered to scrutinize tax rulings under State aid rules. However, the EU Court set a high evidentiary standard for the Commission to meet and will now require a thorough analysis under the OECD's Transfer Pricing Guidelines.
Looking Ahead: If the Commission intends to continue examining tax planning measures involving transfer pricing rulings under EU State aid rules, it will face the more burdensome task of applying a functional approach to its transfer pricing analyses as well as taking into account the existence of "arm's length ranges."
In 2016, the European Commission adopted a decision concerning two tax rulings issued by Ireland in favor of two Apple group companies (ASI and AOE), which are incorporated, but not tax resident, in Ireland. According to the Commission, these tax rulings resulted in an effective corporate tax rate of less than 1%, which is considerably lower than for other taxpayers.
To eliminate any competitive advantage gained from government support, the Treaty on the Functioning of the European Union prohibits State aid to undertakings unless justified by special reasons (e.g., economic development in special areas or sectors, social aid, natural disasters, etc.). In this case (where there were no such special reasons present), the Commission found that Ireland's tax rulings constituted unlawful and incompatible State aid, and ordered Ireland to recover €13 billion from Apple. Ireland, ASI, and AOE brought an action for annulment of that decision.
The EU Has the Power to Scrutinize Tax Rulings
In its judgment, the General Court confirmed that the Commission could scrutinize tax rulings under State aid rules and determine whether they gave rise to more favorable tax treatment compared to what would be considered "normal taxation" under national law. The General Court also ruled that the normal allocation of profits within a corporate group may be defined by reference to the so-called "arm's length principle" (according to which intra-group arrangements must take place under commercial conditions equivalent to those between wholly independent enterprises), provided that this principle is reflected in national law. When applying this principle, the Commission may rely on the OECD's Transfer Pricing Guidelines.
No Proof that Ireland Gave Apple Preferential Tax Treatment
The General Court nevertheless overturned the Commission's decision because it found that the Commission had wrongly declared that Apple had been granted a selective economic advantage by reason of these rulings and, by extension, illegal State aid under Article 107(1) TFEU.
First, the Commission concluded that the tax rulings had endorsed the allocation of profits made outside of North and South America to the head offices of ASI and AOE, which were located outside Ireland and had no employees. According to the General Court, the Commission did not undertake a sufficiently concrete assessment of whether the profits generated outside of North and South America should in fact have been attributed to Apple's Irish branches under national law.
The General Court held that the Commission should have assessed the actual functions and real activities taking place in those branches, such as the design, creation, and development of intellectual property, as well as strategic decisions such as those regarding new product launches and supply contract. It should then have determined whether and, if so, to what extent, the activities took place inside versus outside Ireland and therefore whether and, if so, how much, taxable income was appropriate to attribute to the Irish branches. In this case, since activities and functions were found to be undertaken outside Ireland, the two tax rulings, which attributed very little effective income to Ireland, would not seem to have constituted a selective advantage under the arm's length principle.
Secondly, the Commission maintained that the approximation of market conditions in the tax rulings departed from the arm's length principle. Although the General Court concurred that the rulings were incomplete and occasionally inconsistent, it held that such defects would not necessarily have led to a reduction in Apple's taxable profits in Ireland and were therefore insufficient to prove the existence of a selective advantage contrary to EU State aid rules.
Finally, according to the General Court, the Commission did not prove that Ireland had exercised a broad discretion that was not based on objective or consistent criteria when issuing its rulings to the two Apple entities. As a result, it had not demonstrated that these rulings constituted a selective advantage.
The Commission has the right to appeal the judgment.
Two Key Takeaways
- Following the Starbucks and Fiat judgments, the General Court has confirmed once again that the European Union may use the arm's length principle (particularly as enunciated by the OECD) to determine whether tax rulings give rise to illegal preferential treatment and a selective advantage under State aid rules. This judgment serves to further emphasize that the arm's length principle is not only a useful tool but an important one in defining what "normal" taxation would be (for purposes of testing for selective advantage), provided that this principle is embodied or otherwise reflected in national law.
- The General Court has set a high evidentiary standard for the Commission to meet when it seeks to prove the existence of illegal State aid. The Commission will now have to undertake a more thorough analysis of any ruling under the OECD's Transfer Pricing Guidelines in order to meet its burden of proof. In particular, the trend in transfer pricing analyses to look at a functional approach, as well as the existence of "arm's length ranges" (rather than one single arm's length price) will render the Commission's task more burdensome. Effectively, it mirrors the difficulties that many tax authorities have had in challenging intragroup pricing for tax purposes before national courts.
Originally published by Jones Day, July 2020
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